Large caps look more attractive as market correction improves valuations: DSP MF report

Large-cap stocks are emerging as the more attractive segment of the Indian equity market as valuations have corrected, while mid- and small-cap stocks remain relatively expensive, according to DSP Mutual Fund’s latest Netra Report.

The report said valuations of the Nifty 50 have moved closer to fair or inexpensive levels, with the trailing price-to-earnings (P/E) ratio at 19.26x against a historical median of 20.9x. The price-to-book (P/B) ratio stands at 2.75x, compared with a historical median of 3.5x. In contrast, mid- and small-cap valuations remain elevated, making the fund house selectively more positive on large caps.

Market correction has been more about time than prices

The recent market correction has largely played out through time rather than a sharp decline in prices. The Nifty spent 145 consecutive trading days below its 200-day moving average, making it the eighth-longest such stretch in the dataset. Yet, its maximum decline below the 200-DMA was only 11.5%.

DSP MF described the phase as a “classic time correction”, where earnings, dividends, and book values have continued to catch up while stock prices remained largely range-bound.

The report also highlighted the unusually wide valuation gap between large caps and SMIDs. Small-cap and mid-cap relative valuations versus the Sensex are around 72% and 56% above their respective historical medians.

Historically, periods of extreme SMID outperformance have eventually been followed by mean reversion. However, DSP MF cautioned that there is no certainty on when such a reversal could occur.

India’s underperformance versus emerging markets hits rare extreme

The relative performance of Indian equities against emerging markets has also deteriorated sharply. Between July 2025 and September 2026, the MSCI Emerging Markets index gained 39.3% in US dollar terms, while the Nifty declined 14.6%, resulting in a 53.9 percentage-point gap in returns.

According to the report, the correction in Indian equities has taken place through a combination of price, time, and currency adjustments, improving the relative setup for Indian stocks.

At the sector level, defensive and quality segments have also seen a significant valuation reset. IT, private banks and staples are now trading at roughly the same forward valuation as cyclical sectors, compared with a historical premium of around 70%.

The sector analysis found IT, private banks, FMCG, financial services, chemicals and cement near the bottom of their historical return distributions. In contrast, CPSEs, PSU banks, telecom and capital goods remain above their historical base rates.

FII selling remains extreme, but flows show signs of turning

Foreign institutional investor (FII) selling has reached an extreme level, with rolling 24-month flows at -$56.2 billion—the weakest reading in the dataset since 2012. Twelve-month flows stood at -$26.7 billion.

However, the latest three months have shown an early improvement, with FII flows turning positive at $3.7 billion. The buying has also started to broaden across sectors, suggesting that investor positioning may be gradually shifting.

Taken together, DSP MF’s analysis points to a market where large caps offer a more favourable valuation setup while the elevated relative valuations of mid- and small-cap stocks leave them more vulnerable to a potential mean reversion.